16 May 2011 Internal T.I. 2011-0399521I7 - Replacement property

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Were the land and buildings owned by the taxpayer disposed of as a result of a voluntary disposition or an involuntary disposition for the purposes of the replacement property rules? 2. Does a particular property acquired as a replacement property need to be acquired and used by the taxpayer or a related person on or before the expiry of the applicable replacement property time limit?

Position: 1. The disposition was voluntary. 2. The property needs to be acquired and used on or before the expiry of the applicable time limit in order to be a replacement property.

Reasons: 1. The proceeds of disposition (POD) did not fall within one of paragraphs (b), (c) or (d) of the respective definitions of POD in section 54 and subsection 13(21) of the Act. 2. The property was not used as required before the applicable time limit.

								May 16, 2011

	XXXXXXXXXX  TSO					HEADQUARTERS
								Income Tax Rulings
			  						Directorate
	Attention : XXXXXXXXXX 				Sandro D'Angelo
								(613)952-5803

								2011-039952

XXXXXXXXXX and Replacement Property Rules

This is in response to your memorandum dated March 15, 2011, concerning XXXXXXXXXX (the "Taxpayer") request to have the "replacement property rules" in subsections 13(4) and 44(1) of the Income Tax Act (the "Act") apply in the following situation.

Facts:

Based on the information contained in your memorandum and the additional information you provided with your request our understanding of the key facts is as follows:

• The Taxpayer was the owner of certain land and buildings located at XXXXXXXXXX (the "Former Property") in XXXXXXXXXX . The Taxpayer's taxation year ends on XXXXXXXXXX .
• The Former Property was leased to XXXXXXXXXX ("Opco"). Opco is a corporation that is related to the Taxpayer.
• Opco owned and operated a XXXXXXXXXX business pursuant to a franchise agreement with XXXXXXXXXX at the above location for approximately XXXXXXXXXX years.
• In XXXXXXXXXX , the Former Property was sold to an arm's length purchaser (the "Purchaser") for $XXXXXXXXXX pursuant to a purchase and sale agreement entered into between the Taxpayer and the Purchaser.
• The sale of the Former Property was conditional in that Opco was required to sell its existing XXXXXXXXXX business to the Purchaser. XXXXXXXXXX agreed to grant Opco a new XXXXXXXXXX agreement in XXXXXXXXXX .
• In XXXXXXXXXX , the Taxpayer purchased vacant land in XXXXXXXXXX (the "XXXXXXXXXX Property") for $XXXXXXXXXX . The XXXXXXXXXX Property was acquired for the purpose of constructing new facilities for the new XXXXXXXXXX.
• The Taxpayer reported a taxable capital gain and recapture from the sale of the Former Property on its XXXXXXXXXX T2 return. The "initial year" for the purposes of the replacement property rules is XXXXXXXXXX .
• During the Taxpayer's XXXXXXXXXX taxation year, the Taxpayer was waiting for zoning approvals and building permits in order to commence construction of the new XXXXXXXXXX facilities on the XXXXXXXXXX Property. Some initial ground work (site mobilization) was done on the XXXXXXXXXX Property and the Taxpayer spent $XXXXXXXXXX for costs associated with site mobilization, engineering, architect and permit fees.
• On XXXXXXXXXX , the Taxpayer signed a fixed-price construction contract with a contractor to have the new XXXXXXXXXX facilities constructed for $XXXXXXXXXX . This money was held in trust on the basis of a fixed-cost agreement between the parties.
• When the Taxpayer filed its XXXXXXXXXX T2 return it requested the Canada Revenue Agency ("CRA") apply the replacement property rules to defer part of the taxable capital gain and recapture that arose from the disposition of the Former Property in XXXXXXXXXX .
• Construction of the new XXXXXXXXXX facilities was substantially completed in XXXXXXXXXX and the new XXXXXXXXXX commenced operations on or about that time.

Issues:

1. Was the Taxpayer's sale of the Former Property voluntary or involuntary (i.e., did the Taxpayer's proceeds of disposition ("POD") in respect of the disposition of the Former Property fall under paragraph (a) or one of paragraphs (b), (c) or (d) of the respective definitions of POD in subsection 13(21) and section 54 of the Act)?

2. Does the Taxpayer's replacement property (i.e., the land and building in XXXXXXXXXX ) need to be "acquired and used" in the new XXXXXXXXXX business or just simply "acquired" on or before the expiry of the applicable deadline set out in subsections 44(1) and 13(4) of the Act?

Taxpayer's Position:

The Taxpayer's representative maintains that the Taxpayer's sale of the Former Property to the Purchaser should qualify as an involuntary disposition which would give the Taxpayer at least two years to replace the Former Property (i.e., until the end of its XXXXXXXXXX taxation year). While several arguments have been raised, the Taxpayer's representative essentially maintains that the Taxpayer's disposition of the Former Property was involuntary because both the Taxpayer and Opco had been under considerable pressure from XXXXXXXXXX to develop the Former Property to conform to the current XXXXXXXXXX franchise specifications pursuant to the terms of the Franchise agreement that XXXXXXXXXX had with Opco.

In any event, the Taxpayer's representative also maintains that the both XXXXXXXXXX Property and the fixed price construction contract should qualify as replacement property that was acquired and used by the Taxpayer before the end of its XXXXXXXXXX taxation year.

Tax Service Office's ("TSO") Position:

It is your view that the Former Property was not the subject of an involuntarily disposition since the Taxpayer sold the property pursuant to a purchase and sale agreement (i.e., the Taxpayer received POD described in paragraph (a) of the respective definitions of POD in subsection 13(21) and section 54 of the Act). As such, the Taxpayer only had until XXXXXXXXXX to replace the Former Property.

It is also your view that the Taxpayer's fixed-price construction contract does not constitute the acquisition and same or similar use of the buildings that formed part of the Former Property on or before XXXXXXXXXX . In particular, for the purposes of determining whether a particular property is a replacement property of a former business property, subsections 13(4.1) and 44(5) of the Act effectively require that the particular property actually be used for the same or similar use as to which the former property was put before the particular deadline. As noted above, since the new building on the XXXXXXXXXX Property was not in existence on or before XXXXXXXXXX , it is your view that such property could not have been put to the same use as the Former Property before it was constructed.

Our Comments:

Subsections 13(4) and 44(1) of the Act permit a taxpayer to elect to defer the recognition of income or capital gains where a "former property" is involuntarily disposed of, or a former property that is a "former business property" is voluntarily disposed of, and a "replacement property" is acquired. Where the former property has been involuntarily disposed of, the replacement property must be acquired before the later of the end of the second taxation year following the initial year and 24 months after the end of the initial year. However, where the former property has been voluntarily disposed of the replacement property must be acquired before the later of the end of the first taxation year following the initial year and 12 months after the end of the initial year. (footnote 1)

Paragraphs 13(4)(a) and 44(1)(a) of the Act provide that in order for a particular disposition of former property to be considered as being involuntary, the POD must fall in one of paragraphs (b), (c) or (d) of the definition of POD in subsection 13(21) of the Act or section 54 of the Act, as the case may be. These paragraphs are basically the same in the aforementioned POD definitions and read as follows:

"(b) compensation for property unlawfully taken,

(c) compensation for property destroyed, and any amount payable under a policy of insurance in respect of loss or destruction of property,

(d) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given,"

As the Former Property was not disposed as a result of property taken under statutory authority we will focus our analysis on paragraphs (b) and (c) and ignore paragraph (d).

Unlawful is defined in the Encarta World English Dictionary as illegal, not permitted by the law. It is our understanding that XXXXXXXXXX did not terminate its franchise agreement with Opco, at least not without Opco's concurrence. Moreover, even if the Taxpayer did receive some pressure from XXXXXXXXXX to sell the Former Property such pressure does not equate to the unlawful sale of the Taxpayer's Former Property. Moreover, since the Former Property was not destroyed we fail to see how any part of the Taxpayer's POD could reasonably be consideration as compensation for property destroyed.

In fact, since the Taxpayer's sale of the Former Property took place as a result of a negotiated purchase and sale agreement between arm's length parties we agree that the disposition of the Former Property was a voluntary disposition (i.e., the Taxpayer's POD are the sale price of property that has been sold as described in paragraph (a) of the definition of POD in subsection 13(21) of the Act and section 54 of the Act, as the case may be). Accordingly, the Taxpayer needed to acquire property that was considered as a replacement property by XXXXXXXXXX .

Paragraph (a.1) of subsections 13(4.1) and 44(5) set out that a particular property that replaces a former property must not only be acquired by the taxpayer such property must also be used by the taxpayer or a person related to the taxpayer for a use that is the same as or similar to the use to which the taxpayer or a person related to the taxpayer put the former property. As discussed in ruling documents 2003-0012135 and 2005-0156171E5, the CRA's position is that the particular replacement property must be both acquired and put in use on or before the applicable deadline. A review of the relevant jurisprudence, including the case law cited by the Taxpayer's representative, in our view supports the CRA's position on this matter.

For instance, the courts have held that a property must meet all the conditions in subsections 13(4.1) or 44(5), as the case may be, in order for it to qualify as a replacement property at a particular time. In Glaxo Wellcome Inc. v The Queen, 98 DTC 6638, the Tax Court of Canada further indicated that property that was "intended to be used" or "waiting to be used" was not in fact being "used" in any meaningful sense of that word. Subsections 13(4) and 44(1) will only apply, inter alia, where the taxpayer acquires a property that is a replacement property for a former property. Based on this wording, a property cannot be a replacement property for a former property where such property has not met all the conditions set out in subsection 13(4.1) or 44(5), as the case may be, before the end of the relevant time period set out in subsections 13(4) and 44(1).

Based on the above, we agree that the XXXXXXXXXX Property and the fixed price construction contract were not replacement property as such property was not put to the same or similar use as the Former Property on or before XXXXXXXXXX .

We trust our comments will be of assistance and we would be please to consider any additional representations that might be made by the Taxpayer or its representative on this matter.

Yours truly

Michael Cooke
Acting Manager
For Director
Business and Partnership Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 The respective references to 24 months and 12 months are based on draft legislation and is intended to apply to dispositions occurring in taxation years that end on or after December 20, 2000.